The Benefits of a Balanced Settlement Plan: A Case Study

Proper settlement planning is crucial to maximizing quality of life for plaintiffs in personal injury cases. However, the planning formula is often treated as an afterthought and hastily pulled together in the final stages of a prolonged legal process.  Too frequently, the first annuity payout presented is chosen without any examination of the effect it will have on the plaintiff’s future well-being. This often leads to multiple financial problems for the plaintiff and a much lower standard of living than could otherwise be achieved with some careful, unbiased analysis.

The following case study illustrates how careful, balanced planning can result in many more millions of dollars over a beneficiary’s lifetime.

Fact Pattern: A boy, “Angel,” now six years of age received a substantial settlement from a medical malpractice award.  Angel is paraplegic, uncommunicative and requires a feeding tube. He has complications due to a resultant cerebral palsy condition and will require extensive therapies throughout his life. His mother speaks only Spanish and she lives with Angel’s stepfather; neither is highly educated.  They wish to retain control of their son’s assets and are confused as to why a special needs trust is recommended.

Award: The matter was preliminarily settled for $6.5 million, net of costs and liens.  The parents are considering a structured settlement proposal, which would provide $8,000 monthly for life, with 20 years guaranteed.  Angel’s average rated age was determined by various insurance companies to be approximately 33 years old, and his average life expectancy was calculated at 65 years of age. The parents and their consumer attorney are unsure about the best solution for Angel’s long-term needs.

Background: The personal injury (PI) attorney in this matter had many years of experience and was patient and informed enough to establish a Qualified Settlement Fund to allow time to conduct comprehensive settlement planning.    

As the parents were evaluating their choices at settlement, it was imperative to have an unbiased way to assess various alternatives for how the award was to be received. Even educated plaintiffs need a way to compare disparate structured settlements and lump-sum payouts. Because the PI attorney had no knowledge of how to advise the clients on financial matters – and didn’t wish to take on the liability of doing so – the legal team turned to a registered financial advisor with experience with litigation proceeds to analyze the complicated options and establish a plan that met Angel’s unique needs.

In order to evaluate assorted payment proposals, the financial advisor used a sophisticated financial planning process known as probabilistic forecasting, or Monte Carlo simulation.  This method accounts for variability of investment returns into the future, while adjusting for taxes and expense inflation, to provide a basis for making financial decisions regarding how a settlement should be allocated to best fit the injured party’s future needs.  The decision factor evaluated was, “What is the achievable budget over the life expectancy of the plaintiff with a very high degree of certainty?”  Various settlement options were compared to determine which would provide the highest budget – after taxes and inflation, net of costs – with a 90 percent or better statistical confidence of success through Angel’s entire life expectancy.

The structure broker in this case did an excellent job of searching for the best rates and incomes for Angel. The structure proposal provided two companies, with combined payments of $8,000 per month for Angel’s life, with 20 years of guaranteed payments. The cost for this income stream was the entire net award, $6.5 million.

Structured settlement payments are often applied to settlement awards, as they are tax free and provide surety of income payment over a lifetime.  However, the guaranteed rates of return that a client will receive through his life expectancy are pitifully low – especially when inflation is taken into account. Such plans also have no principal liquidity, providing no flexibility to adapt to changing life circumstances that inevitably occur over 30, 40 or 50 years. This commonly results in a “factoring sale” of the annuity, which comes at a major loss to the client. 

Stock and bond market investments can provide a more reasonable return on the claimant’s award, as well as allowing convenient lump-sum withdrawals for life’s big-ticket necessities. However, this introduces risk into the beneficiary’s asset plan and should be undertaken prudently and with proper diversification and control. Appropriate trusteeship is also crucial to ensuring the assets benefit the claimant rather than related parties.

Depositing all or a portion of the claimant’s funds in an investment account in the name of the special needs trust could provide a significant increase in Angel’s return on his award and his allowed annual budget. But the risks had to be analyzed and controlled to avoid loss of principal over time.  Very conservative estimates were used in determining the average annual return on his invested monies – 4.13 percent return – utilizing an income-based portfolio consisting of 42 percent stock, 48 percent bonds and 10 percent short-term, interest-bearing investments.

The results of the analyses made a compelling case for a balance between the structure and the investments. Neither a 100 percent structure solution nor the 100 percent investment program provided the best results for Angel. The various combinations shown below indicate a very high success rate and significantly improved the budget for any of the combinations of surety and return: 

Choosing the best solution is not simply a mathematical exercise, but must be adjusted to account for a particular client’s tolerance for risk and volatility. The tradeoffs between an enhanced lifestyle and changeable monthly statements are real. The clients in this matter, in consultation with their legal team, opted for the 60 percent liquid special needs trust (SNT), 40 percent structured annuity solution, which should add $86,160 to their annual budget for 59+ years.  That represents an improvement of $5,083,440 over Angel’s lifetime!

The legal team and family in this matter found great success with a balanced settlement plan allocation that combined the surety of a structured settlement annuity with the increased return and liquidity of the invested SNT funds.